President Obama announced in his State of the Union speech last night that the US should raise the minimum wage rate to $9/hr. Does this again prove that the Administration is full of heart, but lacks economic understanding?
Wages rise, and to a lesser degree fall, based on the needs of the market. If more firms increase their need (demand) for labor then the prevailing wage rate will increase. If specialized labor is required by a firm, it will increase its wage rate to attain employees with required skills, until that position is filled. When an employee accepts a position at a specific wage rate, a mutually-beneficial agreement has been entered between the employer and the employee. In theory, both parties are happy as they have both agreed to the wage. This is inherently the fairest economic process for employment.
The minimum wage rate, which is currently $7.25 per hour, is only offered and accepted when the value of the labor is greater than or equal to the wage they are offering. Currently if a company wants to hire labor that they value at $7.00 per hour, they will not hire an employee and inefficiencies occur. The company now has an extra $7 per hour that they would love to spend on a new employee, but instead will retain until the value they place on that position’s work exceeds $7.25. This is inherently inefficient and creates unemployment.
If the federal minimum wage rate is forced even higher, more workers will be forced out of the market and even greater market inefficiencies will be incurred. Companies do not suddenly value employee output at a greater rate when the government requires them to pay more. They balance the new required rate by lowering employment or demanding greater output per hour of employment, if that is possible.
In addition, higher payroll costs increase firms’ per unit costs and will in turn reduce the aggregate supply. Remember supply and demand from basic economics? When supply goes down, all else held equal, costs will increase. Expect inflation to also follow.
It really is common sense. When you raise a firm’s costs, or all firms’ costs within an industry, or the entire market’s costs, aggregate employment decreases, efficiency decreases, and American firms suffer. Unfortunately, what the Obama Administration doesn’t seem to understand is that companies don’t suffer those inefficiencies, they are eventually passed down to the consumer and employee…that’s you and me.
Justin Vélez-Hagan is the National Executive Director of The National Puerto Rican Chamber of Commerce and an Adjunct Instructor of Economics at the University of Maryland-University College. He is also the Sr. Contributing Writer for Politic365 and can be reached at Justin@Politic365.com or @JVelezHagan.